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Fallout: The Financial Crisis

Deflation can lead to a scary scenario

Marketplace Staff Nov 19, 2008
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Kai Ryssdal: If you think consumers are having a hard time with deflation, imagine how businesses feel. Virtually all of them depend on credit. Tumbling consumer prices and less money out there to lend in the first place add up to a pretty scary scenario, as Marketplace’s Jeremy Hobson reports from New York.


Jeremy Hobson: Things are moving fast in the credit markets. Take it from Guy Lebas, chief fixed income strategist at Janney Montgomery Scott.

Guy Lebas: When we were seeing oil prices at record highs back in July, deflation was a very, very distant worry. Now it’s become kind of front burner.

As debt becomes more expensive, companies don’t want to borrow as much, especially when deflation is driving down their income. Martin Wolfson is an economist at Notre Dame. He says remember what happened to borrowers when deflation hit home values.

Martin Wolfson: So, as they are unable to pay their debts, they default. This means losses at the banking system. The banks contract or are unwilling to lend. This slows down the real economy.

Now, imagine that happening at businesses across the country. Think about what that would do to the economy. Irving Fisher wrote about this very problem back in 1933. He was a Yale Economist who warned about what he called debt deflation. Here’s a dramatization.

Actor: Unless some counteracting cause comes along to prevent the fall in price level, such a depression as that of the 1929 to 33 tends to continue, going deeper, in a vicious spiral, for many years. There is then no tendency of the boat to stop tipping until it has capsized.

Now, Fisher added, there is a way to right the ship — reflation, in other words, printing more money. When Fed Chairman Ben Bernanke mused about the possibility of a deflationary spiral back in 2002, he said doing so [helicopter noise] amounted to dropping sacks of cash from helicopters to stop it.

In New York, I’m Jeremy Hobson for Marketplace.

Ryssdal: That was Rico Gagliano there for that dramatization. Never passes up an opportunity, does he.

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